BSE Smallcap: Are Valuations Stretched? A Closer Look into the Metrics

The S&P BSE Small-Cap Index tracks small-sized companies on the Bombay Stock Exchange (BSE), with 946 companies listed. It is heavily weighted in the financial (6%) and chemical (6%) sectors, followed by pharmaceuticals (5%) and IT, steel, auto ancillary, and infrastructure sectors (4% each).

The index has delivered strong performance, up 30% YTD and 46% over the past year, significantly outperforming the Sensex, which rose 10% YTD and 22% over the past year. BSE Small Cap Index is currently trading 3% below its all-time high.

P/E Ratio –  A Deep Dive 

The BSE Small Cap Index currently has a Price-to-Earnings (P/E) ratio of 33.8, which is above its median of 33.1 over the past year and notably above the median of 27.8 over the past 5 years.

In the short run (1 year) the index is trading at a price level that is in line with its recent historical valuation range. This might suggest that the current valuation is not excessively high relative to its short-term trend.

Over the long term (5 years), the index is significantly more expensive than usual. This indicates that investors are willing to pay more, possibly reflecting expectations of higher future growth in the index. 

From December 2021 to December 2023, the P/E ratio of the S&P BSE Small-Cap Index has consistently traded below its historical median, indicating that the index was undervalued relative to its long-term average. This undervaluation likely reflects investor caution, as small-cap stocks were less favoured during this period because of factors such as high interest rates and inflation concerns.

P/B Ratio – BSE Smallcap Index 

The current Price-to-Book (P/B) ratio of 4.1 for the BSE Small Cap Index, which is above both its 1-year median of 3.6 and its 5-year median of 2.5, indicates that the index is trading at a premium relative to its historical averages. This suggests that the market is valuing the index higher than its underlying book assets justify, potentially increasing the risk of a correction if expected growth does not materialise.

Dividend Yield – Below 5-Year Median 

The current dividend yield of 0.6% matches the 1-year median of 0.6%, indicating stability in both dividends over the past year. However, when compared to the 5-year median yield of 1%, this lower yield suggests that stock prices have risen without a proportional increase in dividends. This trend may indicate that stock valuations are becoming stretched relative to underlying earnings or profitability. 

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.